LIFE, HEALTH AND DISABILITY Life Lessons By Phillip E. Stano, Steuart H. Thomsen, and Wilson G. Barmeyer The industry s experience with unclaimed property shows the upheaval caused by a novel legal theory in the hands of cash- strapped states and contingency-fee auditors. The Life Insurance Industry s Experience with Unclaimed Property The past four years have given the life insurance industry a rude introduction to a new approach to unclaimed property regulation. State treasurers seeking fresh sources of revenue to fill holes in state budgets have turned the unclaimed property laws governing life insurance on their head in an effort to impose new liabilities on insurers. Contingency- fee auditors, deputized as state agents, have initiated dozens of multistate insurer audits and regulatory examinations that have fostered regulatory upheaval. The auditors have applied a controversial legal theory that would accelerate the timing for when life insurance proceeds become unclaimed property. Under the laws of many states, life insurance proceeds are presumed abandoned and must be remitted to the state as unclaimed property a certain number of years referred to as the dormancy period after the funds become due and payable referred to as the dormancy trigger as determined by the records of the company. Most insurers interpret these statutes as requiring a claim and the receipt of proof of death to trigger the dormancy period for unclaimed property purposes. Additionally, some states require an insurer to remit the proceeds a certain number of years after the insurer knows that an insured has died. Without a triggering event, however, unclaimed property obligations do not arise. State treasurers, unclaimed property auditors, and some insurance regulators, however, have sought to create from whole cloth a new rule that the dormancy period for life insurance proceeds begins automatically upon an insured s death, regardless of whether an insurer has received a claim or is even aware of the death. Auditors have sought to obtain from insurers the names and the Social Security numbers of their insureds for the purpose of comparing the records with information in the Social Security Death Master File (DMF), a record of deaths maintained by the government. Through data matching, often inexact or fuzzy matching, the auditors purport to learn of deaths about which insurance companies were previously unaware, and on which no claims have been filed. The auditors then contend that the insurance pro- Phillip E. Stano and Steuart H. Thomsen are partners and Wilson G. Barmeyer is an associate in the Litigation Group in the Washington D.C. office of Sutherland Asbill & Brennan LLP. Their practice focuses on financial services litigation and class action defense and includes representing clients on all facets of unclaimed property issues. 30 For The Defense December 2014
ceeds are abandoned and should be remitted to the states as unclaimed property. More than a dozen large insurance companies agreed to settlements with regulators under which they would search the DMF for all of their insureds, identify potentially deceased individuals, locate beneficiaries when possible, and remit monies to the states if the beneficiaries could not be located. And unrelated to any regulatory settlements, approximately 15 states have passed legislation mandating DMF searching and follow up. Amidst these developments, disagreements between the industry and state regulators over the application of unclaimed property laws governing life insurance have spilled over into litigation, and the cases have now advanced to state and federal appellate proceedings. A series of recent case rulings provides insurers with new ammunition for correcting the regulators misapplication of the law. Insurers litigation efforts are paying dividends for the industry: the courts have thus far uniformly rejected the regulator- auditor positions that dormancy begins at death and that insurers have a legal duty to search for information about possible deaths of insureds. Key issues pending before the courts in these cases include the following: 1. When do life insurance policy proceeds become unclaimed property? 2. Do life insurers have a legal duty without newly enacted legislation to use the DMF or other similar databases to search for information about possible deaths of their insureds? 3. Are there any limits on the scope of information that a state auditor may request during an unclaimed property audit? When Do Life Insurance Policy Proceeds Become Unclaimed Property? The threshold issue in the dispute between regulators and the industry is when the dormancy period begins for life insurance policy proceeds. Unclaimed property auditors and insurance regulators assert that the dormancy period begins on the date of an insured s death, regardless of whether the beneficiary has filed a claim or whether the insurer is even aware of the death. Insurers contend that the dormancy period begins upon the insurer s receipt of proof of death, the date the insured attained or would have attained the limiting age under the policy, and in some states, upon knowledge of death. The industry recently scored a big victory in the Florida Court of Appeals and is defending a lower court victory before the West Virginia Supreme Court of Appeals. First, on August 5, 2014, the Florida First District Court of Appeal held in Thrivent Financial for Lutherans v. State of Florida, Department of Financial Services, No. 1D13-5299 (Fla. Ct. App. Aug. 5, 2014), that Florida s unclaimed property law does not trigger obligations by the mere fact of an insured s death. Instead, an insurer s duties under Florida s unclaimed property statute are triggered only by receipt of proof of death, knowledge of death, or when the insured reaches the limiting age under the policy. Life insurance proceeds are due and payable for purposes of Florida s unclaimed property statute when an insurer receives proof of death, not before, and the unclaimed property statute does not impose an affirmative duty on insurers to search death records to ascertain whether an insured has died. Thrivent sought a declaratory statement from the Florida Department of Financial Services (DFS) that life insurance proceeds become due and payable as established from the records of the insurance company under the Florida Disposition of Unclaimed Property Act when the insurer receives proof of the insured s death and surrender of the policy. In response, the DFS issued a declaratory statement that concluded that life insurance proceeds become due and payable for unclaimed property purposes upon the death of the insured. The DFS interpreted the dormancy period trigger for unclaimed property as the mere fact of death. Thus, policy proceeds would become due to the state as unclaimed property three years after death, regardless of whether an insurer received a claim or was even aware of a death. The insurer appealed the DFS s declaratory statement to the Florida Court of Appeal. The appeals court reversed the DFS s declaratory statement, holding that the DFS interpretation of the statute was clearly erroneous. Construing the provision that proceeds become due and payable as established from the records of the insurance company, consistent with the Florida Insurance Code provision that payment shall be made upon receipt of due proof of death and surrender of the policy, the court held that the records of an insurer do not establish proceeds as due and payable until the insurer receives Most insurers interpret these statutes as requiring a claim and the receipt of proof of death to trigger the dormancy period for unclaimed property purposes. proof of death and surrender of the policy. The court stated that [n]othing in the plain language of [the statute] supports [the] DFS interpretation that funds become due and payable at the moment the insured dies. The court noted that if proceeds become automatically due and payable at the time of death, that would render meaningless the subsequent provision that contracts not matured by actual proof of the death become due and payable when an insurer knows that an insured has died or when the insured attained or would have attained the limiting age. This ruling is particularly significant because it applies a plain language interpretation to Florida s statute, which is based on the widely adopted 1981 Uniform Unclaimed Property Act. This ruling is now final: the time to appeal the ruling has expired without any action by the DFS. Second, the West Virginia State Treasurer is appealing the dismissal of 63 separate but virtually identical cases filed against life insurers alleging violation of the 1995 Uniform Unclaimed Property Act as adopted in West Virginia. State of West Virginia ex rel. John D. Perdue, Nos. 12-C- 287 et al. (W. Va. Cir. Ct. Dec. 27, 2013). Among other issues, the trial court rejected For The Defense December 2014 31
LIFE, HEALTH AND DISABILITY the West Virginia State Treasurer s claim that the dormancy period for life insurance begins upon the date of an insured s death, as opposed to the date of proof of death. Reading the state s unclaimed property statute (UPA) together with the state s insurance code, the trial court noted that the Insurance Code conditions an insurer s liability upon the presentation of a The court therefore ordered that the audit should be delayed pending the insurer s challenge to the underlying basis of the audit. claim, which requires that a claimant provide an insurer with notice giving rise to liability under a policy. In the court s view, [t]he provisions of the UPA and the Insurance Code are unambiguous and consistent with one another. Defendants have no obligation to surrender the life insurance proceeds under the UPA until the obligation to pay arises either upon receipt of due proof of death or once the insured reaches the statutorily imposed limiting age. Observing that the due proof of death requirement is an essential ingredient for creating the obligation (i.e., the property ) in the first place, the court concluded that for life insurance proceeds, there is no property subject to or reportable under the UPA until the beneficiary has made a valid claim and submitted proof of death or the insured obtains the limiting age. These cases are now pending before the West Virginia Supreme Court of Appeals, the state s only appellate court, and briefing was completed in September 2014. Do Life Insurers Have a Legal Duty to Use the DMF to Search for Information About their Insured s Deaths? Another core substantive issue is whether insurers have a legal duty under state unclaimed property laws to use the DMF to search for information about possible 32 For The Defense December 2014 deaths of insureds and then take affirmative steps to reach out to beneficiaries. Since 2011, model legislation drafted by the National Conference of Insurance Legislators (NCOIL), now known as the Unclaimed Life Insurance Benefits Act, or NCOIL Model Act, has been passed by 15 states, expressly requiring insurers to use the DMF to search for information on possible deaths of insureds. Before the first of these acts took effect, several affiliated insurers brought a declaratory judgment action challenging the retroactive application of the Kentucky version of the law. A Kentucky state trial court rejected the insurers argument, but on August 15, 2014, in another big win for insurers, the Kentucky Court of Appeals issued a decision reversing the trial court, holding that the statute applied to newly issued policies only and did not apply retroactively. United Ins. Co. of Am. v. Kentucky, No. 12-CI-1441 (Ky. Ct. App. Aug. 15, 2014). The court held that Kentucky s duty to search the DMF statute, Ky. Rev. Stat. 304.15-420, clearly imposes new and substantive requirements which affect the contractual relationship between insurer and insureds. Most notably, the act shifts the burden of obtaining evidence of death and locating beneficiaries from the insured s beneficiaries and estate to the insurer. The appellant insurers had argued in part that the notice and proof of death requirements in their policies created a condition precedent for payment of death benefits and that [u]ntil that condition precedent is met, the insurer has no contractual obligation to investigate a claim or to make payments. The court agreed, stating that [w]hile Kentucky has never applied this particular application of condition precedent, it is a reasonable interpretation of the contracts at issue. By definition, a condition precedent is an event which must occur before performance under a contract becomes due. Consequently, the court held that the act imposed a substantive alteration of the contractual relationship, and because the statute did not expressly apply retroactively, it was interpreted as not having retroactive application to contracts in force before the act s effective date. Separate and apart from the NCOIL DMF legislation, many state regulators have taken the position that existing unclaimed property laws or insurance laws already require insurers to conduct such searches, even in states that have not adopted new DMF search legislation. Several courts have now considered, and thus far have uniformly rejected, the regulators position on this issue. First, the regulator position on DMF searching was soundly rejected in the recent Florida case discussed above, Thrivent v. Florida, No. 1D13-5299 (Fla. Ct. App. Aug. 5, 2014). The DFS took the position that the Florida unclaimed property statute created an affirmative duty of an insurer to search the DMF or similar commercially available databases to determine if any of its insureds have died, ostensibly for the purpose of identifying purported unclaimed property. The court disagreed, holding that [n]othing in the plain language imposes an affirmative duty on insurers to search the DMF or other database to determine whether any of its insureds have died. Also in Florida, but in a separate case, a different panel of the same Florida Court of Appeals has affirmed the disposition of a case where the lower court decision stated that Florida has not adopted a law requiring [an insurer] to consult the Death Master File and likewise has adopted no law imposing an obligation on [an insurer] to engage in elaborate date mining to search for deaths of insureds. See Total Asset Recovery Servs. LLC, v. Metlife, Inc., Case No. 2010-CA-3719 (Fla. Cir. Ct. Aug. 20, 2013), affirmed per curium No. 1D13-4420 (Fla. Ct. App. Sept. 19. 2014). Second, in the West Virginia appeal, the appellate court is expected to consider the trial court s holding that there is no general good faith requirement in the UPA [West Virginia Unclaimed Property Act] that requires insurance companies to search the DMF or other third-party database to determine when an insured has died. State of West Virginia ex rel. John D. Perdue, Nos. 12-C-287 et al. (W. Va. Cir. Ct. Dec. 27, 2013). The lower court rejected several of the West Virginia State Treasurer s positions as policy arguments more properly considered by the legislature, noting that the recent adoption of DMF legislation in several other states suggested that no such duty existed until new legislation was enacted.
Third, the only federal appellate court to consider the DMF issue the U.S. Court of Appeals for the First Circuit has also affirmed an insurer victory. In the case below, a federal district court in Massachusetts, in Feingold v. John Hancock Life Insurance Co., 2013 WL 4495126 (D. Mass. Aug. 19, 2013), rejected claims by a private plaintiff that an insurer must affirmatively search the DMF. The putative class action complaint accused the insurer of using the DMF asymmetrically, by allegedly routinely searching the database to end payments to annuity clients but not using it to notify beneficiaries promptly of life policies when a policy- holding relative dies, and thus avoiding payment of life insurance policy death benefits that are owed to beneficiaries. The complaint asserted that the insurer was liable for damages to policy holders and beneficiaries because of these alleged asymmetrical practices. The district court granted the insurer s motion to dismiss, which argued that the complaint sought to discard settled law by requiring payment or reporting of life insurance proceeds without the beneficiaries making a claim on the policy. Noting that the case depended on established principles of insurance law, the court observed that [a]n insurance policy may require a beneficiary to furnish due proof of loss, in this case proof of death, before paying policy proceeds. The court held that the insurer s practice of requiring a beneficiary to submit proof of death before the insurer would pay any policy proceeds comports with both Massachusetts and Illinois law. On May 27, 2014, the U.S. Court of Appeals for the First Circuit affirmed the insurer s practice of requiring life insurance beneficiaries to submit proof of death before it would pay death benefit proceeds under the policy at issue. Citing Illinois precedent for the proposition that the proof of death requirement was a reasonable requirement in an insurance policy, the court held that this proof of death notice requirement complies with Illinois law and is in accord with Illinois s unclaimed property statute, which acknowledges that life insurance proceeds are not payable without proof of death. The First Circuit rejected the beneficiaries argument that the insurer was required to consult the DMF to check whether life insurance policy holders were deceased. What Information Must Be Provided in an Audit? Several insurers have resisted providing information requested by unclaimed property auditors, and at least one case is now before an appellate court in California. Unlike the substantive issues, for which insurers have secured a string of victories, the results in these cases have been mixed. In one case, the California Court of Appeals is reviewing a preliminary injunction issued in October 2013, ordering an insurer to furnish state auditors with all data and documents requested by the state in the course of an audit. Chiang v. American Nat l Ins. Co., Case No. 34-2013-00144517 (Sup. Ct. Sacramento Cal. Oct. 9, 2013), on appeal, No. C07248 (Cal. App. 3d Cir.). The California State Controller initially challenged the insurer s refusal to produce records on its currently in-force policies, thereby preventing the Controller from having access to records allegedly necessary to complete the unclaimed property audit. Specifically, the California State Controller s complaint alleged that the company had failed to take reasonable steps to determine whether the insureds under their life insurance and annuity products are deceased and alleged that these practices have resulted in both substantial delays in the escheatment of amounts due from the life insurance industry and the failure to escheat such amounts at all. Nearly simultaneously, the California State Controller moved for a preliminary injunction, seeking to enjoin the insurer s alleged refusal to allow a full, complete and accurate examination of all its books and records in response to data requests from the Controller and his auditor. Characterizing the refusal to produce certain information as dilatory tactics, the Controller claimed that it does not, and need not, accept the insurer s word that it has, on its own, correctly identified and segregated its own in-force policies. In response, the insurer argued that the information at issue data on in-force policies could not constitute reportable unclaimed property under any circumstances and was therefore entirely irrelevant to the audit. The insurer also filed a four-count cross-complaint, seeking a declaratory judgment that (1) the California State Controller was not entitled to obtain in-force policy data, (2) the Controller lacked the authority to enforce any DMF- searching obligation, (3) the Controller lacked authority to challenge or to change the company s contractual relationships with its insureds as part of the audit, and (4) death was not the dormancy trigger under California law. The trial court granted the Controller s preliminary injunction request and Thus far, the life insurance industry s common sense and plain language interpretation of unclaimed property laws as applied to life insurance has been vindicated in the courts. ordered the insurer to produce information on in-force policies. The court stated that the insurer is depriving the State of the ability to review the company s records to identify escheatable property because California s auditor does not, and need not, accept [the insurer s] word that it has, on its own, correctly identified and segregated its own in-force policies. The court also dismissed the Counts 2 4 of the insurer s cross-complaint for declaratory judgment, which sought to present substantive legal issues regarding the DMF and applicable dormancy trigger. The court held that these issues were not ripe for review and stated that the court would not speculate as to what the Controller s audit will reveal or express an opinion on the validity and scope of such hypothetical exactions. The court, however, allowed the insurer s declaratory judgment claim regarding policy data to survive, and permitted the insurer to take discovery to determine whether the Controller had a reasonable belief that the insurer had failed to report unclaimed property. The insurer has appealed the trial court s rulings. Property, continued on page 90 For The Defense December 2014 33
Property, from page 33 More recently, in a different case involving the California State Controller, an insurer has succeeded in in opposing the controller s motion for preliminary injunction regarding the scope of the audit. Thrivent Financial for Lutherans v. John Chiang, California State Controller, No. CGC-13-535156 (Cal. Sup. Ct. Sept. 2, 2014). The court held that the Controller had failed to establish a likelihood of success on the merits, irreparable harm, or that the proposed audit was limited to the inspection of reasonably relevant information. The court therefore ordered that the audit should be delayed pending the insurer s challenge to the underlying basis of the audit. Further rulings in these pending cases may provide guidance on the scope of information that an auditor may request in an unclaimed property audit and on the permissible use of that information. Conclusion The life insurance industry s experience with unclaimed property shows the upheaval caused by a novel legal theory in the hands of cash- strapped states and contingencyfee auditors. Thus far, the life insurance industry s common sense and plain language interpretation of unclaimed property laws as applied to life insurance has been vindicated in the courts. Yet the industry will never return to the status quo: the landscape has been altered by a growing body of DMF legislation, the practical effect of multi-state settlements, numerous court decisions, and many insurers voluntary efforts to search for insureds deaths using the DMF. 90 For The Defense December 2014